Treating Capital Right

By

James Smalhout

April 8, 2002 12:01 a.m. ET

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When Robert Mugabe, despotic leader of Zimbabwe, got himself re-elected president last month, the event should have provided a reality check for the 50 heads of state who were jetting off to Monterrey, Mexico for a United Nations powwow on "Financing for Development." Mugabe, a pariah who richly deserves every bit of opprobrium that the world community has heaped upon him, sent thugs to roam the country, intimidating members of the opposition party and murdering dozens of its leaders. The electoral process therefore lacked what is politely called credibility.

Not coincidentally, Zimbabwe's economy -- which not long ago showed respectable growth -- is a shambles. Agriculture is flat on its back after Mugabe began turning over private farms to his political lackeys. This once-thriving agricultural exporter now looks to import 1.5 million tons of corn a year to feed its 12 million people. Gone, too, are the tourists from picturesque Victoria Falls -- and their valuable foreign-exchange earnings.

Tough Medicine

It would have been difficult to imagine a more sobering prelude to the "Spirit of Monterrey"-- a high-falutin' proclamation cooked up by U.N. functionaries before the conference in Mexico. (The U.N. is the kind of organization that writes the decision of a conference before holding it.) The document calls for rich countries to double their aid to poor countries. It says, against all the evidence, that such increased generosity could eliminate world poverty in the next 15 years.

Fighting poverty is a worthy goal, deserving of support all around. But the facts speak louder than the U.N.'s hope for human betterment. Sub-Saharan Africa's GDP actually has shrunk in the past 35 years. And no amount of aid will put things right for the 500 million people living in poorly governed countries worldwide, as long as tyrants like Mugabe maintain their grip on power.

Charles Calomiris, in A Globalist Manifesto, reviews the last 1,000 years of experience with economic development. Western European countries, of course, "took off" first. The leading success stories outside Europe, he points out, are the countries that inherited a rule of law and a tradition of honoring contracts: The U.S., Canada, Australia and New Zealand. Japan has been the only really big success outside Western Europe that developed on its own. A few countries -- notably South Korea, Brazil, India and Taiwan -- have made great strides, but they haven't yet emerged as major creators of wealth for the world economy. Saudi Arabia joined the club of rich countries by exporting lots of oil, but it has not used its windfall to become an economic dynamo.

Today's development agencies and the heads of state they advise tend to underestimate the need for similarly deep reforms. The world landscape is strewn with false starts. Argentina is the most recent example of a country that masqueraded as a reformer while in fact not living within its means or working to increase national wealth.

The key factors for success most often have been open markets and the rule of law. Another $50 billion in foreign aid -- or double the current amount, as called for by the Monterrey conference -- is simply no substitute for those two things.

The good news is that donor countries, led by the U.S., are starting to insist on results. President Bush has offered to boost American spending on aid by $10 billion over three years. But recipient countries will need to show that they care enough to do what it takes to put themselves on the road to development. Otherwise, they won't get any of the increase. In principle, this sounds solid, but the trick will be making it work in practice. International aid agencies have a proven track record of looking at poor countries through rose -- tinted glasses, often misjudging their true commitment to reform. Setting a clear standard is, at least, a reasonable way to start.

The importance of foreign aid for lifting countries out of poverty pales in comparison with trade and investment. Too many governments in poor countries don't care about development. They see aid as a way to subsidize political patronage in the health clinics and schools (e.g., Pakistan) and big construction projects (e.g., Kenya). Aid spending can do little good unless medicines are on the shelves, kids have textbooks and somebody maintains the roads. Poor countries could earn more than twice the value of all foreign aid if governments simply eliminated trade barriers.

End of Redlining?

The world's poorest countries also lag far behind in the global race to attract new investment. The overwhelmingly important question, almost never asked, is whether this is cause or effect. Is a lack of capital the cause of their poverty or do they lack capital because of policies that impoverish their people?

However, the Monterrey delegates also rubber -- stamped a pre -- arranged declaration of intent to channel private capital to the underdeveloped world. More export credits and loan guarantees definitely were on the shopping list. And the delegates in Monterrey also wanted rich countries to pick up more of the tabs for feasibility and engineering studies, as well as for marketing new investment opportunities. Contractors and consultants from rich countries often turn out to be the main beneficiaries.

In case somebody didn't notice, low investment has not been the cause of Africa's dismal performance. Investment there has been too high and too easy rather than too low, according to research by William Easterly, who worked as a World Bank economist until recently. Capital invested in Africa, both public and private, has not been productive. In part, bad government policies have shown an aversion to market forces and sponsored weak technology. In part, the capital sent to Africa has been free money. Charity is rarely as well spent as retained earnings.

If the rich countries of the world sponsor a new investment wave in poor countries without dealing with the institutional and philosophical problems, they will merely put the cart before the horse. "Capital is a coward," as Treasury Secretary Paul O'Neill likes to say. "It wants to go where it knows that it will be treated well."

Even Easterly admits that international investors have been ignoring some worthy countries in the developing world. Take Uganda. The country clearly has been making many of the right moves. It has a freely convertible currency. It opened its economy to foreign trade and it adopted structural adjustment programs recommended by international lenders. The country's finance minister, Gerald Ssendaula, complained during a recent appearance in Washington that Uganda has done everything humanly possible to create a positive climate for private investors, but without reward.

The disasters -- Argentina currently, Russia in 1998, Asia's crisis countries the year before and Mexico in 1994-95 -- get the headlines. But there are signs that markets are starting to discriminate. Mexico's peso, for example, kept climbing as Argentina's currency board imploded late last year. The next positive sign might be an end to red -- lining the entire continent of Africa, rather than lumping a Uganda together with a Zimbabwe.

Empty Spirit

If the rich world is gearing up for another major attempt to provide development assistance, the "Spirit of Monterrey" is no sign that it's going to go well. Certainly, there's no reason to think that any amount of development aid will achieve the U.N. goal of eliminating global poverty by 2015. But some countries, perhaps only a few, will improve themselves during that time frame. There were, after all, success stories during the past 20 years. Greece, Portugal and South Korea have been among them.

With or without aid, there will be new success stories in the years immediately ahead. Look for countries that work toward limited, corruption -- free government and honor contracts, rather than those that support vast patronage empires by wheedling handouts from international donors and lenders. Those are the places where new aid will have an impact.

This is no time to open the cash drawers, mindlessly following the lead of an international agency or accepting a national political subsidy. Instead, investors should take a surgical approach. All markets do not emerge alike. Buyers and lenders should beware of big governments, beware of grandiose promises, beware of perfect solutions. Even the most charitable investors should seek opportunities that can be measured by cash return, and they should be sure that profits will be sheltered under the rule of law.

When investors and lenders get that right, they will at last be creating the right conditions for development.

James H. Smalhout is a researcher, financial writer and visiting fellow at the Hudson Institute.

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